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Blog Discussion Thread: Economic Theories of the Great Depression

The great depression was the most severe economic depression ever experienced in Western civilization.

The research methodologies I intend to use will examine the different theories on the Great Depression. These theories are the Monetarist Theory, the Keynesian Theory, the Common Theory, and the Austrian Theory. Some will come from books and others from web articles. So, let’s go ahead and investigate some of these theories.

Common Theory

“The most widely accepted theory that explains the Great Depression is that governments are to be held responsible for changes in fiscal policy during all economic climates. Thus, they should aim to keep aggregate money supply and aggregate demand growing steadily in the long run. For instance, during a recessionary period, liquidity in the banking system should be increased, and taxes should be cut to prevent the collapse of money supply and demand.

In the case of the Great Depression, most governments were either too slow to react or didn’t react. Some economists even argued that economic depressions were a good thing since (i) they forced failed investments to liquidate and (ii) they allowed capital and labor to be freed up from unproductive businesses and channeled into growing economic segments.”

Monetarist Theory

“The Monetarist Theory blames banks and the U.S. Federal Reserve for not taking measures to protect the economy during the Great Depression. As the money supply shrunk by 35% and CPI fell by 33%, the Fed took too long to respond and did not lower interest rates, increase the monetary base, or inject liquidity into the banking system in time.

The delay caused stock market indices to drop significantly, which led to investors panicking and selling off their securities. Cumulatively, these factors allowed what was otherwise an intense recessionary period to become the Great Depression.”

Keynesian Theory

“The Keynesian Theory was formulated by British economist John Maynard Keynes. It states that the government’s top priority is to keep employment as high as possible during recessionary periods by running deficits. Keynes’ theory also noted that governments needed to increase public sector spending or sharply cut taxes.”

Austrian Theory 

“Austrian economists argue that the Great Depression was the inevitable outcome of the monetary policies of the Federal Reserve during the 1920s. The central bank’s policy was an “easy credit policy,” which led to an unsustainable credit-driven boom. The money supply inflation during this period led to an unsustainable boom in asset prices (stocks and bonds) and capital goods. When the Federal Reserve belatedly tightened monetary policy in 1928, it was too late to avoid a significant economic contraction. Austrians argue that government intervention after the crash of 1929 delayed the market’s adjustment and made the road to complete recovery more difficult.”

When looking at the various economic theories of the Great Depression, let’s begin with the Monetarist.

The Monetarist Theory blames banks and the Federal Reserve for not taking measures to protect the economy during the Great Depression.

The Keynesian theory states “that the government’s top priority is to keep employment as high as possible during recessionary by running deficits.”

The Austrian theory argues that the Great Depression was “the inevitable outcome of the Federal Reserve’s monetary policies during the 1920s.”

Lastly, the Common Theory explains that “the great depression is that governments are to be held responsible for changes in fiscal policy during any economic climate.” 

All these theories technically have in common is that they all blame the government and the banks. However, what they all do not have in common is how the government should have protected the US economy. For example, let us look at the Monetarist and Keynesian theories. The Monetarist suggested that the Feds took too long to lower interest rates or inject liquidity into the banking system. Keynesian’s argument is somewhat similar but the exact opposite. They argue that the government should inject more money into the system by investing heavily in the public sector.

The Austrian school argues that the great depression was due to the Federal Reserve’s monetary policies, making credit easy. Making credit easy caused inflation, thus driving prices higher and creating many bubbles within the economy. By the late 1920s, the Federal Reserve noticed it was too late to do something. However, that did not stop them from making the same mistake again by making additional adjustments to the economy. This is where the Austrian school argues that not only did the government cause the Great Depression by interfering with the money supply but exacerbated it by continuing to tinker with the market even after the Depression had fully hit, causing the delay of any correction for some time.

So, who is right?

Frankly, they are all on point to a degree. All the schools of thought appear to blame the government and banks for doing too much or too little. All schools of thought believe money is the issue. All schools of thought feel that any adjustment is good or bad. In other words, all schools of thought place one in a “catch-22” scenario or damned if you do and damned if you don’t conundrum. 

It was only after WW2 that the US economy finally took off and ended the depression. From 1929 to 1945, the US economy pumped money into the public sector. From 1929 to 1941, much of America was still unemployed. From 1941 to 1945, the US was fully employed in the public sector due to WW2. Once the war ended, the public sector went bust, and the private market flourished, thus ending the depression. From 1929 to 1945, the US economy was depressed due to government interference. 

Nevertheless, one of many issues all schools of thought point out is that the government is the cause of the crisis. Therefore, why place faith in an institution to pull us out of such a crisis? A previous blog/video stated that democracy works best in the marketplace. 

As Frederic Bastiat once stated, “Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.”

References

Website

“The Great Depression – Overview and Main Economic Theories.” Corporate Finance Institute. Accessed June 11, 2021. https://corporatefinanceinstitute.com/resources/knowledge/economics/the-great-depression/#:~:text=Common%20Theory.

“The Causes of the Economic Crisis, and Other Essays before and after the Great Depression | Ludwig von Mises.” Mises Institute, August 18, 2014. https://mises.org/library/causes-economic-crisis-and-other-essays-and-after-great-depression.

“Did Hoover Really Slash Spending?” Mises Institute, May 7, 2010. https://mises.org/library/did-hoover-really-slash-spending.

Books

Friedman, M and A J Schwartz. A Monetary History of the US 1867-1960. Princeton University Press, 1963.

      Keynes, John Maynard and Mark G Spencer. The General Theory of Employment, Interest and Money ; the Economic Consequences of the Peace. Ware, Hertfordshire: Wordsworth Editions Limited, 2017.

      Murphy, Robert P. The Politically Incorrect Guide to the Great Depression and the New Deal. Washington, Dc: Regnery Pub. ; New York, 2009.

      Rothbard, Murray, America's Great Depression (Ludwig von Mises Institute, 2000